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An Income Doubling Strategy...

For the past several weeks in my Cycle Prophet Report, I have discussed my 'sell-premium' strategy. This week, I'm going to give a very specific example of what I am talking about, including a trade that could generate some substantial income.

The objective of this strategy is to take what the market gives you and sell it back to the market with the objective of generating income regardless of whether the market goes up, down or sideways, and at some point along the way, a decent profit. When the market gives us volatility, I look for stocks with the right profile that can generate what I call "An Income Doubling Strategy." In reality, this strategy can generate far more income than just a doubling.

If you were to put your money in the bank or buy T-Bills, your income is virtually nil. But, let's say you are one of the 'big-boys' and can actually generate 3% on your money by buying bonds of one type or another. With my sell-premium strategy, I believe you can make a lot more income and have less risk.

Here's how the strategy works:

Find a high-quality equity that has little or no chance of going to zero.

Make sure the equity has as low a "PEM" as possible. PEM = Price divided by Expected Move. This is a term and a value that I provide to my CycleProphet Tools subscribers. I coined the term, "PEM".. The lower the PEM, the easier it is for the equity to achieve its "Expected Move" or "EM". An equity's EM is an estimate of how much it is likely to move in price for a specific period of time and stay within one standard deviation of its normal volatility.

If possible, try to find equities that have weekly options with plenty of volume and relatively tight bid/ask ranges. There are two primary reasons why I like weekly's:

1. In a volatile market that can change trend virtually overnight, it is important to be very tactical in your investing. For example, we have the on-again-off-again financial meltdown in Europe, which can certainly roil the markets and create multi-week shifts in trend. My 'sell-premium' strategy has a bull or bear bias associated with it. I would rather make that decision on a weekly basis than on a monthly or longer-term basis when the word's economy and markets seem to be very tenuous with regard to stability and growth.

2. Option contracts have an intrinsic-value (demand-driven component) and time-value.(the amount an investor is willing to pay above the intrinsic-value. Each day, the time-value of the option decreases as it gets closer and closer to the expiration date, where the time-value eventually becomes zero. When there are only a few days left (as in a weekly option contract) before the contract expires, the degradation of the time-value is significant. When selling a call option, which this strategy uses, the goal is to have the option expire worthless so that I can sell the next week's option and do this over and over and over. More on this, below.

I have two primary goals with this strategy:

1. Generate a minimum of 0.5% in weekly cash income from the sale of option premium. If I am successful for an entire year on this strategy, I can theoretically generate well over 20% in cash income.
2. Get the equity "called away" from me at a healthy profit.

The key, of course, is to find an equity that meets all of the above criteria.

Next week, I will show you how I use CP Tools to find these equities and how I use a combination of search criteria and watch lists.

One stock that fits my 'sell-premium' strategy is FCX. Keep in mind that this week is the normal monthly options expiration week, so this is not the best week to put this trade on. Also, I am using it as an example and by the time the markets open on Tuesday, these numbers will have changed and may make this trade more or less attractive. This is for teaching value only... I already have this equity in one or more of my portfolios and I may trade in or out of it in the future.

Freeport-McMoRan Copper and Gold Inc. engages in the exploration, mining, and production of mineral resources. The company primarily explores for copper, gold, molybdenum, silver, and cobalt. It holds interests in various properties, located in North and South America- the Grasberg minerals district in Indonesia- and the Tenke Fungurume minerals district in the Democratic Republic of Congo. As of December 31, 2010, the company's consolidated recoverable proven and probable reserves totaled 120.5 billion pounds of copper, 35.5 million ounces of gold, 3.39 billion pounds of molybdenum, 325.0 million ounces of silver, and 0.75 billion pounds of cobalt. The company was founded in 1987 and is headquartered in Phoenix, Arizona.

(Click to enlarge)

Here are the details about what I like about this equity for my sell-premium strategy:

1. The volume is in the 14 million to over 20 million range, per day.
2. Its PEM is only about $10 with an Expected Move of $4.21. This means that if the stock remains within one standard deviation of its EM (Expected Move) and remains in a positive trend, it could easily move $4 or more per week to the upside.
3. The stock is selling for $42.00. A weekly option contract, one strike out of the money ($43) sells for about 55 cents. Selling the 43 call for 55 cents will generate 1.31% in income for one week. Do this for 52 weeks and you can generate nearly 70% in a year. Of course, these numbers will not exist every week, but you get my idea.
4. If the stock's price moves above $43 and if I do not "roll the call", then the stock will get called away from me. I will have made $1 in the price of the stock and 55 cents from the sale of the call. I will have made $1.55 on a $42 stock in one week. This is a net return (excluding transaction fees) of 12.92%.

Is there risk in this trade? Of course. The price for FCX could drop significantly, but the fundamentals, technicals and time-cycle forecasts do not indicate that a substantial drop in FCX is likely. Still... it could happen. Such is the inherent risk of the stock market.

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